October 24, 2024 • 42 mins
By now, everyone knows that private credit is a hot market. What's less known is that banks want in on it too. It's an odd state of affairs given that both these entities are in the business of making loans, so in theory they should be competing against each other. But instead we're seeing a bunch of deals, with more than a dozen big banks teaming up with private credit over the past year. So why are two seemingly natural competitors joining forces? And how much of an existential threat does private credit really pose for the banking industry? On this episode, we with speak with Huw van Steenis, vice-chair at Oliver Wyman and a long-time bank analyst at Morgan Stanley, about this new dynamic.
Read More:
The Macro Impact of the Private Credit Boom
The Black Hole of Private Credit
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Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:03):
Bloomberg Audio Studios, Podcasts, radio News. Hello and welcome to
another episode of the All Thoughts Podcast.
Speaker 2 (00:23):
I'm Tracy Alloway and I'm Joe Wisenthal.
Speaker 1 (00:26):
Joe, I feel like I start every private credit episode
with the same point, but I mean, private credit it's
everywhere right now. I think I counted like dozens and
dozens of stories on private credit that came out just
on the Bloomberg in the past week.
Speaker 3 (00:41):
There's two funny things that are going on. Which is
one private credit. So these non bank entities providing loans,
et cetera wanting to get into credit, and there's more
and more about that every day. And then there's banks
wanting to get more and more into private credit, which
is his own thing of Okay, you're still at the bank,
but you're doing it in some sort of bald and
she'd structure that resembles private credit, and what's up with that?
Speaker 1 (01:05):
What's up with that? Indeed, this is the what's up
with that? Episode? I'm so glad you asked that question.
But we're going to be talking about the relationship between
banks and private credit because the other thing that's been
happening is every time we talk to a bank or
a private credit entity on this show and we ask
about the relationship between regulated banks and non banks, you
(01:25):
get this really diplomatic, kind of awkward answer, like while
we view our bank partners as opportunities and no one
will really explain how they actually feel about each other totally.
Speaker 2 (01:37):
You know.
Speaker 3 (01:37):
The one other thing before we get into it that
I think about it a lot is I look at
the rise of private credit and there is a big
part of me that says, this is what regulatory success
looks like. This is what post DoD Frank's success looks like.
That there is more of this risk taking, right, this
was the intent, Yeah, happening outside of the deposit taking
banking institution. On the other hand, if a lot of
(02:01):
the leverage for private credit and a lot of these
relationships is being plied by banks and so forth, then
it makes me wonder, did we actually extricate the risk.
Speaker 1 (02:12):
Or in the air we just put a wrapper on it, we.
Speaker 3 (02:14):
Put a rapper on it. In the end, does all
financial risk readown back to the banking system?
Speaker 1 (02:19):
That's exactly it. And I got to say, you know,
there is a lot of discourse from which we can
pull from a lot of historical analogies, because of course,
bank disintermediation is not a new thing. It's basically been
happening for as long as we've had banks. And if
I think back to like two big moments in the
process of bank disintermediation, it has to be the invention
(02:39):
of the junk bond market in the nineteen eighties, securitization.
Also in the nineteen eighties and nineteen nineties, peer to
peer lending. That was a fun one, remember that.
Speaker 3 (02:49):
Well the other thing too, you know, it just occurred
to me. And bear Stearns was not a retail deposit
taking institution. But part of why they blew up is
like they had these in house hedge funds, right, and
so even this idea of hedge funds and non bank
entities sort of existing within more larger, traditional regulated financial
institutions is not that new. That was a story of
(03:09):
the Great Financial Crisis.
Speaker 1 (03:11):
That's exactly right. So I'm very happy to say this
is our banks and private credit basically Frenemies episode. We're
going to be speaking with really the perfect guest. It's
someone that I've known for a long time and we've
actually had him on the podcast before. But I don't
think you were there. I promise you are really going
to love this. We're going to be speaking with Hugh
van Steinis. He is the vice chair at Oliver Wyman
(03:33):
and also the former global head of Banking Research over
at Morgan Stantley. That's where I got to know his
during the depths of the euro Zone financial crisis when
I was on FT Alpha bel He's also formerly an
advisor to Mark Karney at the BOE. I think he
won like a series of research awards at various points
in his career, but really one of the smartest guys
(03:54):
I know when it comes to banks and financial So, Hugh,
thank you so much for coming on.
Speaker 2 (03:58):
All thoughts. Tracy, thanks so much for having me on.
Speaker 1 (04:02):
We are very excited. First of all, maybe let's just
start with the basic question, because everyone seems to have
different opinions, different numbers around this, But how big is
private credit at the moment compared to the traditional banking system.
Speaker 4 (04:17):
Oh, I mean, honestly, it's pretty tiny. So the official
stats are about one point seven trillion, and that's by Prequeen,
the company that Black Croc bought recently. That number, though
doesn't include insurers giving direct mandates to the private credit firms.
So I think it's probably closer to two and a
half to three trillion, which is a drop in the
ocean to what investment grade bond markets nine trillion banking
(04:38):
assets in Europe at thirty two trillion. These are really
relatively small numbers, and so I think that's why many
of these firms think they've got a long run way
still to grow.
Speaker 3 (04:46):
So why do we care. If not because they're so big,
it's just because it's growing.
Speaker 4 (04:49):
Fairst Well, it's also because they're eating away at bank earnings,
and I think that's where, you know, if I think
about our conversations with bank CEOs and CFOs, and I
literally just had one before coming on your show, they're
worried about how much of their juice is being gobbled up.
And I think that that's you know, that's why in way,
Tracy's Right has gone from sort of counterparts to frenemies.
(05:12):
And one way to think about it is that we
had a very unusual macro period. As you've spoken about
many times, during twenty twenty three, private credit players wrote
about ninety percent of all leverage loans, and they're also
doing really well in direct lending. And so they're looking
for the next avenue of growth. And one theme that
we come up across a lot is about asset back lending,
(05:33):
so in other words, financing i'd know, aviation, or auto
loans or even royalties. That's a five and a half
trillion dollar market in the States. Private credit probably has
less than five percent share, and they're really looking to
mine this seam. And so if you're a banker, thinking,
these guys are now after durre investment grade assets, not
just are the high old assets.
Speaker 1 (05:53):
So talk to us about how we got to this
point because Joe correctly, I think, attributed this to a
lot of the post two thousand and eight redesign of
the financial system regulation. And I mean, this is what
we wanted, right, We wanted the riskiest stuff, the riskiest
activity to be pushed away from regulated banks and into
(06:14):
I know they have the nefarious name of shadow banks,
but you know, mostly we're talking about like a business
development company or a direct lender or someone like that.
Speaker 4 (06:23):
No, look, I think that's right. So looks if you
take it since the financial crisis, where we changed the
rigs for the banking system, a lot more capital, a
lot less shortened the asset liability duration, a mismatch that
went beyond an elastic limit into the financial crisis. So
these private credit firms have created just over a trillion
dollar parallel system to lend to corporate America and parts
(06:47):
of corporate Europe. And it's around leverage lending its areas
which were either too risky or in some cases where
the FED put in limits on how many leverage loans
or what was the maximum you know, multiple of level
that a bank loan could take on. And so these
loans are being pushed outside of the banks. The other area, though,
where private credit has been very active to is mid market.
(07:09):
So let's say a loan between let's say thirty million
dollars to seventy five million dollars. That's a narrow where
for the top six banks, this is just too small
fry for them to get excited. And therefore so there
was us kind of a missing piece, which you know,
the private credit firms picked up the crumbs which are
left on the table by the bank. So you're right,
I think the regulators push this. I think where we're
going now is probably to the next level. And so
(07:32):
what I the way I think about it is that
we are now retranching the banking system where the banks
are laying off the junior risk to private credit, and
that's allowing them to optimize their capital, but quite frankly
also lend more. And so what's really interesting for me
is there's, like everything in life, people see things as
an opportunity or a threat. The top banks and CEOs
(07:52):
that I talk to are now saying, actually, private credit
allows me to recycle risk more quickly, I can lend more.
And then there's a whole bunch of banks who are
just sitting licking their wounds, going I'm not sure how
I can do this. So I think there is a
little bit symbiosis now between the banks and private credit.
Speaker 3 (08:06):
SORR explain that a little bit further, at least on
the opportunity side, when they can recycle their capital first,
just sort of walk us through.
Speaker 4 (08:13):
The Yeah, so Joe, let's take one of the top
top us banks or your banks. So there are three
ways they can lay off risk. The first would be
to say I will seed the loans that I don't
really want to write to give to a third party.
So in a way, what you've seen with Apollo and
City Group is the is the leverage lending or Brookfield
(08:36):
with Lloyd's in Europe. Again, it was around leverage lending.
So it's stuff that they didn't really want to do,
but they can arrange. They can get all sorts of
origination fees, and then they can also keep the relationship.
The second is if they let's say, originate a loan,
they then pass that up, maybe get one hundred loans
on hundred twenty loans, and then do a synthetic risk
transfer around this, in other words, start to basically which
(08:57):
I think you talked about two months ago on your show.
So in that case, think about a bell curve, you're
going to ensure the bottom ten percent, you're going to
take off the tail, and from a bank capital point
of view, that dramatically optimizes your capital at risk. So
the FED only permission this is about nine months ago.
You've already seen Morman, Sandy, Golden Sacks a number of
firms start to do these synthetic risk transfers. That space,
(09:20):
I think is going to grow really strongly because for
the largest firms it allows them to lend and then
do them. And then the third is then the more
you know, there's some more complexities as well around you know,
how else you can sort of lay off the risk.
Speaker 1 (09:47):
So one thing I'm always asking on the show is
how these conversations begin, because you know, I honestly have
no idea. Like, clearly there's a lot of partnering that's
happening between banks and private credit at the moment, but
when did that start? In your mind, what was the
first kind of big, notable instance of a bank teaming
(10:08):
up with some sort of private credit entity.
Speaker 2 (10:11):
Oh, that's a good question.
Speaker 4 (10:12):
So, as you were sort of hinted earlier on Tracy,
often in life a history of these things is far
longer than we like to believe. So just like actually
nineteen seventy three was the peak of bank lending as
a percentage of lending to corporates. I mean, it's what,
it's fifty years since that peak. So you're right, some
of these partnerships are actually about fifteen years old. One
or two of them predate the financial crisis. But if
(10:33):
you think about today, in the twelve months to September fourteen,
banks tied up deals with private credit, and in the
twelve months prior it was only two So it's basically
about a year ago. Suddenly it snapped. Now why is that.
I think it's because the private credit firms, particularly the
top ten, felt that started to max out of you know,
leverage lending or direct lending. But I think the subplot
(10:57):
is much more Shakespeare. I think there's a really interesting subplot,
which which is more of the top ten private credit
firms and now getting the assets from insurers. So take
yesterday we had the Blackstone results. Half their assets now
now come from insurance companies. Insurers can only invest investment grade.
So if you think about it from the point of
view the private credit player, they are structurally lowering their
(11:19):
cost of capital, which means that they can then go
after investment grade assets on the bank's balance sheets.
Speaker 2 (11:26):
And so that's subplot.
Speaker 4 (11:27):
I mean, I think now of the top ten firms
on my numbers, about forty percent of the assets come
from insurers. They become much more relevant to compete for
the investment grade pieces on the banks. And I think
that's what you know, whether it's the Barclays deal with Blackstone,
whether it's oak Tree with the SoC Gen, whether it's
City with Apollo. In a way, the private credit is
(11:48):
able to nibble away at more assets than they could
in the past.
Speaker 3 (11:52):
I'm going to back up and ask the dumb question.
I'm like, oh, I think maybe listeners are a lot
of clarification, but it's actually just me. What's the difference
between leverage lending and direct lending?
Speaker 1 (12:01):
Again?
Speaker 4 (12:02):
Oh, look, the this is one of these where the
MAENDC clature is pretty poor. Okay, I mean it's really poor,
and it's pretty blurry. I think the way they think
most of them would think about its direct lending is
I'm lending to a mid market company, you know, thirty
million dollars to one hundred million dollars, the kind of
a mid market finance, whereas lever lending is going to
be acquisition related finance.
Speaker 2 (12:22):
But okay, got it? Yeah, yeah, Joe, it's a it's
a it's a blurry fandomic.
Speaker 3 (12:26):
No, the acquisition related finance. That makes a lot of
sense to me.
Speaker 1 (12:31):
So I'm going to go back to that conversation point
and ask, Okay, so you know, a bank approaches a
private credit lender, or a private credit lender approaches a
bank and says, hey, we need to do something in
this environment. You know, there's a lot of demand. I've
got a bunch of insurance companies that are interested whatever,
how do they go about identifying what exactly they're going
to do and which particular assets are loans might be
(12:54):
realistic for this kind of partnership.
Speaker 4 (12:57):
Oh, it's a that's a great question, Tracy. So and
it cuts look some of these relations These firms are
being counterparts of the banks for many years, so there's
a degree of relationship, even if maybe historically being a
little bit antagonistic, and certainly one of the leaving product
credit firms you know, has a swear box for every
time they talk about a counterpart rather than a partner
these days, how.
Speaker 1 (13:15):
Much do you have to put in? Is it like
five thousand bucks or five dollars?
Speaker 4 (13:20):
Well, it probably should be five thousand, but I think
it's actually got it's the charity. It's a charity pot.
And so if we think about those deals, half have
been around asset back lending and half around the you know,
the overflow, the leverage finance or the more levered stuff.
So I think that what the private credit companies are
doing is very shrewdly going through that. They're almost doing
like my old job being a banks on list. They're
(13:41):
looking at a bank and saying where is capital constrained
at the end of the day, particularly in Europe, but
even in the state and even particularly think about US
regional banks or some of the European banks. They've become optimizers.
They're optimizing for a cost efficiency, capital efficiency and revenues.
And in that mindset of optimization, they're always looking to
try and lay off risk. And so the private credit
(14:03):
company often says, well, look, I see your capital constrained.
Speaker 2 (14:06):
You need to grow.
Speaker 4 (14:08):
An example would be let's say Blackstone with Barclays, they
want to grow their credit card business, but you know,
but equally want to keep lots of money in there
in their vestment bank. By partnering up, they can now
fuel the growth of the credit card business in a
way they couldn't do before, or did at least didn't
believe they could before. So I think this is, you know,
in a very constrained world. In fact, I was an
(14:30):
event last week with a bunch of investors and private
credit firms, and one of the investors said, well, look,
there is not enough capital for any bank to put
capital behind an acronym. You know that that's just space
is gone. You need to find partners and so I
think they're forensic. They're hiring people to do bank's analysts
for them, and then I look in to try and
(14:50):
create a solution because I said, the top ten firms
feel their origination constraint and so they need the access
to more assets.
Speaker 3 (14:58):
So in a situation like a credit card deal, what
the bank wants and the bank still has, and the
bank will probably still have, is that brand, that relationship,
that retail distribution network and so forth, and then the
private credit entity just allows them to keep growing these
lines and that they're presumably other lines without impairing their
(15:19):
balance sheet.
Speaker 2 (15:20):
Exactly.
Speaker 4 (15:21):
It's about optimizing the castle as well, because you know
it's at the end of the day, if you take
off the riskiest piece, will take off the entire slice.
Then you can just grow much faster.
Speaker 3 (15:29):
That's very helpful. Can you go further in talking about
the role of insurance and all this, because one of
the things that I still find actually completely strange is
that we have these gigantic financial entities called insurance companies
their bad meth and they're important all kinds of areas,
and no one ever talks about insurance companies Either's like
(15:50):
that you don't really see them in the media the
same way you see banks.
Speaker 1 (15:53):
It's very stress that and accounting. Yea, like the two
missing like major ingredients of financial.
Speaker 3 (16:00):
Financial of the financial ecosystem that seemed to like punch
and maybe they like it and punch it like you know,
ten percent of their weight in terms of our understanding
of their role. But talk a little bit more about
their role of insurance capital on a.
Speaker 4 (16:13):
This Oh, this is a great plot. And actually it's
very different in Europe versus the US. But let's say,
if you go back to Tracy point, the railways were
funded mostly by insurance companies. I mean large, large capital
projects were mostly funded by the insurers. So because they
had long dated funding and you still had wildcat you
know runs in the States as you as you may
not remember, but I was there. So so thet you know,
(16:34):
everyone's looked at Apollo and their arrangement with a theme
and seeing that they've created a very they've got a
very stable source of funding through their annuity business, much
like you know you might have seen through the last
actually before even before the financial crisis, hedge funds wanted
permanent capital vehicles, right, everyone wants ee wants to be
aligned to long data capital, and so I think, you know,
(16:56):
most of the top ten now have an insurance business.
So I mean I was just you know, I listened
to the Blackstone call yesterday, two one hundred and twenty
one billion other assets and now from insurers out of
four hundred and thirty two, so over half of their
credit assets come from insurers. Now, obviously that's great because
these are investors with long duration liabilities who need long
(17:16):
dated assets. So they're the right kind of people to
fund data centers, infrastructure assets, you know, the long dated
and stuff we need to fund our growth. But the
interesting thing for private credit is, rather than having to
go for i know, ten to thirteen percent return, if
they can just simply get one hundred to two hundred
basis points more than the insurer could have got through
(17:38):
the public markets, there actually quits in. And so certainly
the expectation for the CIOs of insurers I speak to
is if they can get one hundred and fifty one
hundred and seventy five basis points pick up on a
single a bond by buying a private bond rather the
public bond, if you compound that over ten years, that's
huge for the insurance sector. And so as I said,
I think about forty percent of the ass sets now
(18:00):
of the majors come from insurance. I think for the
industry as always between near thirty and so that's fueling
the growth and it's changing the nature of where private
credit can invest.
Speaker 3 (18:12):
By the way, Tracy, I didn't know that insurance companies
funded the railways, but I will say early on in
my career I do remember, and I sort of pat
myself on the back for this, I do remember having
the realization that sort of like clicked how similar banks
and insurance companies are. Because with the bank, you know,
you make a deposit of one thousand dollars and over
(18:33):
the lifetime the bank will probably give you back your
one thousand dollars in the form of you take it out.
Insurance companies basically the same. You buy a collect premium
and you get the you know on no but like
on average right for the industry, they pay out roughly
what they get in and they hope to like make
it on the float kind of. And so in the end,
like the models, in the ideal sense, it's just a
(18:55):
matter of timing of when the cash goat comes back.
Speaker 1 (18:58):
Out but in aggregate, right, aggregate, but not my individual experience.
Speaker 3 (19:01):
Some people get screwed and some people get way more
than they put in and then on average anyway, Yeah,
sort it sort of clicked to me one time in
my own.
Speaker 1 (19:10):
There's there's a lot of overlap here, for sure. Okay,
So I want to go back to the financial risk
slash regulation points. So we've established a number of times
that to some extent, this is exactly what regulators wanted
to see happen. But I think there's always a concern
that maybe this will come back to bite them and
the overall financial system in some unexpected way, and that
(19:31):
maybe there are avenues that some of this risk is
still entangled with the banking system, especially as we see
these new partnerships develop. What are the avenues for private
credit risk to I guess, re enter the banking system
and potentially cause problems.
Speaker 4 (19:48):
Look, I think it's a great question. I think I've
had almost every regulator post this question. This is this
is one of the very hot buttons for the issue
for them. So look, my take is that for sector
which is very low on leverage, doesn't have the big
asset liability mismatches is not systemically interconnected, and to be honest,
is still relatively small, less than three trillion. It's on
the whole, not a source of systemic risk. But the
(20:11):
question you gather therefore, well, are there pockets of leverage
that we can't see? So, for instance, the Bank of
England's got an investigation to think about where is the
hidden leverage because obviously having had the LDI problems under trust,
they're worried about hidden leverage. So nav finance is an
area which the regulators are pouring over and are getting
trying to get the data from firms just to see
(20:32):
as their leverage on leverage and the system that may
be you know, may trip them up. I think second
would be on the whole. If you've got ten plus two,
if the funds are ten year in duration, or even
even if they're six years and you're lending to five
year loans, there isn't a big asset liberty in mismatch.
But to the extent that private credit may potentially be
(20:54):
put into retail vehicles or even or even to ETFs,
is there going to be an asset liability mismatch. And
certainly the more that private credit looks to raise money
from retail, the more there's going to be a questions
around the structure. And we can come out to that
because there's a Cambrian explosion of interest of traditional asset
managers and private credit players teaming up to create commingle vehicles.
(21:15):
And then the third though, but tracy to your point,
is how do the tentacles overlap. So there is a
good piece by liberty streets. So like the Fed in
New York that twenty seven percent of bank loans are
now too non bank financial institutions, so hedge funds, private credit,
you know, a private equity and the like, and it's
been growing like a weed. And so they're war and
doing you know, you know, at one level they're very
(21:36):
happy that firms are laying off.
Speaker 2 (21:39):
Risk to private credit.
Speaker 4 (21:41):
But they but the question in fact, one of the
big central banks is asking the banks to try and
tos up every loan to private credit firm, every loan
to private credit firm, be in reality they're not making
the loan to the firm. They're doing it to the
underlying asset. But they won't have a consolidated tape because
you know what you don't know, you scares you, And
so they're trying to get a much better transparency on
(22:01):
this space.
Speaker 1 (22:02):
This kind of reminds me of the conversation we had
with Mickey Shemy about synthetic risk transfers, where you know,
it's sort of the same idea. The bank is like
selling off part of the risk of a lone portfolio
totally to another entity. And that sounds fine, except sometimes
those other entities who tend to be hedge funds or
someone like that, are borrowing from banks in order to
apply leverage to boost the yield.
Speaker 3 (22:24):
You say more about the twenty seven percent, I have
to go read the Liberty Street Economics report. But what
is from the bank's perspective that specific type of lending?
What are the risk characteristics?
Speaker 2 (22:36):
What are the.
Speaker 3 (22:37):
Capital impairment the capital cost characteristics of this kind of activity?
Speaker 4 (22:42):
Well, look, so by the way, I'll send you THEA.
I think it's about where do banks end and let
and private markets begin? All banks begin is the title,
So I think, look, it's very heterogeneous at the moment.
So it's hedge funds, and I know that my good
friend Tosin Slocke said that's to a new high it's
to private equity firms.
Speaker 2 (22:59):
So it's all over the place. But so I'm just
like what, Sorry.
Speaker 3 (23:02):
Jake, my question wasn't particularly sorry. I know, my particular
question wasn't particularly cogent.
Speaker 2 (23:08):
Here, it was worse.
Speaker 3 (23:10):
It's like, no, no, no, it's fine, it's fine. I'm just
trying to understand, Like, right, Okay, So banks are optimization vehicles,
they're capital optimization vehicles and so forth, and they want
to like, they want to do the lending that creates
the fewest constraints on the size for regulators and all
that stuff. So where does lending to financial institutions fit
into this sort of like madetrix of costs and benefits?
Speaker 4 (23:32):
Okay, So the way bank REGs work these days is
to encourage the banks to do senior or high quality
lending and to try and limit the amount of riskier lending,
either to try and originate and distribute it very quickly
or to lay it off through you know, derivatives of
some sort. Yeah, and so let's say it's it's lending
to hedge funds. Now, you know, because you've you've spoken
(23:53):
out before with archaegos, they got that wrong. But the
idea was up until then hedge fund lending. I mean
very low risk.
Speaker 3 (23:58):
For el So this is kind of what hedge fund
lending is considered to be low risk.
Speaker 1 (24:03):
Absolutely, although but I think that is changing, like there's
more scrutiny of the prime brokerage business.
Speaker 4 (24:08):
Yeah, exactly, Well, because they had a fifteen e run
with almost no credit losses, and obviously they had good
collateral with haircuts and if and this was the big
question with the firms who got the wrong way around
to our chaegoss was if they got the right haircuts,
then there was secured lending. So on the whole, they
you know, they could seize the assets and sell them off.
What they got wrong was this was such a concentrated
(24:30):
pool and they were all stampeding. So so I think
actually the risk here is not so much the belly,
it's actually the tail.
Speaker 2 (24:37):
So is there a scenario where there's.
Speaker 4 (24:39):
A major credit event and that many companies go bust
and then that works its way through and that's where
the regulators are trying to piece it through. But my
take is on the whole, the banks are trying to
retranch keep the senior risk and I cheekily put in
and the zen pick of the system because this was
a wave for them to lay off risk local.
Speaker 3 (24:59):
Directory very hard. Well, because in my mind, just sort
of very naively, I don't necessarily think of lending to
hedge funds is really safe lending, because aren't they taking
all kinds of crazy risks and doing all kinds of
stuff that may go wrong. But to your point, obviously
beyond just the run, the fact that there it's backed
by actual assets typically or typically the bank knows what
(25:21):
the assets are, I can understand more conceptually why lending
to financial institutions is more frequently perceived as safe. So
thank you for that, Joe.
Speaker 1 (25:29):
I think we should do a prime brokerage episode of
All Lots where all we do is a dramatic reading
of the report on credit Swiss and our ke ghost.
Speaker 2 (25:37):
Yeah, let's do it.
Speaker 1 (25:38):
We just do that, because that was amazing and actually,
well actually a really good insight into how it all works,
or you know, a bad example of how it should
not work. Anyway, Hugh, I'm going to ask a really
basic question, but I find, you know, the changing answers
to this one always really interesting. But how are banks
(25:59):
making money?
Speaker 4 (25:59):
Now? Oh? It's that Look, that's that's a really good question.
So after fifteen years of zero or negative rates, We've
had a wonderful couple of years where spread income, so
the spread between the assets liability once again became profitable,
and that really hurt the banks. But you know, if
the majority of my conversations, both Stateside and Europe and
(26:21):
even in Asia, as the banks want to make more
fee income, so that could be asset management, could be
private banking, could be originate to distribute. They want to
continue to shift more and more of their earnings towards
fees and less from just common and garden banking. And
that's partly cyclical. As interest rates are being cut now,
the anticipation is the kind of the spread is going
(26:41):
to be under a little bit of pressure, but you know,
as we've seen actually it's continued to be very good.
But it's more and more fees that's where that's really
where the banks are focused, and then within the loan income.
My sort of take is that the kind of winner takes.
Most dynamics we've seen in tech are starting to come
to banking. The more of a bank cost base, which
is the systems, the cloud data, you know, it's more
(27:05):
and more the cost space is tech well quite frankly,
it's very scalable, and so what you're starting to see
if you look at the roe. I actually did a
piece the other day where I looked at the ros
for the banks in every country by the number one player,
number two, number three, umber five. The top three players
in each market are doing so much better than the
tails than they wear a decade ago. And I think
it's that winner takes most win, it takes more behavior.
Speaker 3 (27:26):
That's really interesting. Actually, let's talk a little bit more
about this, because I have also from time to time
pull up the chart of JP Morgan and compare it
to other banks, and it is it looks kind of
like a tech dog. I mean, it's not really quiet
as good because it's not a techt Doug, but it
sort of seems to exhibit And I wondered about this,
this sort of winner take on this of the market
(27:48):
and whether there is a similar dynamic. And I hadn't
thought about it quite so literally in terms of the
actual tech stack of the bank, and I was wondering
if it was more sort of like a network effects.
And of course in finance work effects are important just
like they are in software. But talk to us a
little bit about the dynamics that you think are contributing
to this. Winner take on this in any country banking system.
Speaker 4 (28:11):
So look, I think obviously there's part of it is
the is the tech stack. Of course, you know, if
they're trading assets, there's always going to be some network effects.
If you can take you know, thirteen fourteen, fifteen percent
for market, you just see more, you can price better,
you've got better source of flow. So I think in
investment banking markets and in sort of wealth markets, there's
definitely some network effects, but also just there's scale in origination.
(28:34):
I mean, you just need loan officers, loan processors. I
mean it's very typically, it's very manual, and in fact,
one of the not for me, but some of our
colleagues are doing a lot of work actually using AI
to automate loan procedures for banks because that's an area
which is very physical, historically been very labor intensive. And
actually one of the reasons why private credit is trying
(28:54):
to team up with the banks is because they don't
have enough people to originate, so they're trying to lean
on someone else's origination STAF. Now, look, but just there's
one nuance here for every power, there's an equal and
opposite power. So in the States, let's say for regional
back for the smallest banks, they're all basically sitting on
one of three players like five serv So they're enjoying scale,
but they're just outsourcing it. And then the other thing is,
(29:17):
of course, you know the Google's alphabets and as you're
within Microsoft are getting a winning handover fist because if
you're a MidCap bank, the way you try to capture
scale is by outsourcing to one of the superscalers.
Speaker 1 (29:29):
I think you anticipated my next question perhaps when you
brought up AI. But one thing I often think about
the financial sector, so banks and insurance companies, is if
AI is Obviously it's about the technology, but it's about
the data too. Who has the most data? It's got
to be insurers and banks, right, they just have noodles
and oodles of it. How excited are banks in particular
(29:52):
getting about, you know, the actual data component of their
business here?
Speaker 2 (29:58):
Well, hopefully Bloomberg's got one of the best data staffs.
Well us too.
Speaker 4 (30:03):
Oh no, this is so there's a huge amount of
automation going on. I mean, look, let's take one step back.
The banks need to make sure that their data is
organized in a lake or in a way it can
be used effectively. And then number two, you need to train.
So actually one of the largest banks now has every
new graduate doing AI prompt training as part of their
core curriculum as they join. So one of my son's
(30:23):
flatmates just done eight weeks of AI training. It's extraordinary.
So the way, of course, if the more data you've got,
the better. But Tracy, there's some really subtle things in here,
because the regulators want to know how you made the
decisions right, and is the a optimizing just on past
experience or is it right?
Speaker 1 (30:40):
This is the black box alg point, right, where like
if you have all this data going into a black
box and algorithm and it's spitting out an answer, you
actually have to know whether that answer is valid, like
whether it might violate regulations on biased lending based on
like racial or age characteristics or gender or something like that.
Speaker 4 (31:00):
Absolutely, and so there's all sorts of bites. So at
the moment, most of it is for co piloting, but
you know, some of the use cases, Tracy, are fascinating.
It's like one of the big banks I was talking with,
they're actually using AI now in the right sharp departments
to just basically automate and a thing. If they want
to fask someone, they just they click a big thing
less and then try and work it out.
Speaker 1 (31:18):
Oh wow, dystopia is here.
Speaker 3 (31:20):
Yeah, it really is. There's some great articles, by the way,
done by Bloomberg, not related to banks or anything, but
like on the sort of like Amazon auto hiring and firing,
and just this idea of all that being the assumption
of liquid labor markets and the you know, it's okay
to make mistakes if there's just an endless supply of
people who want to work at your company. Anyway, that's
its own digression, you know, just on this point. So obviously, okay,
(31:43):
the big banks have their gigantic text ex. I had
a conversation recently with someone who worked for a very
small bank. Actually it was just like someone over coffee
and I'm curious and so it's like kind of like
doing an odd lots except over coffee with no microphone,
like how it all works and how a region or
a small local bank actually has a business. And it
(32:04):
was really striking in the conversation how many of the
specific things that came up were literally about third party
modeling or software packages and stuff like that, and how
much the sort of all kinds of risk management, et cetera.
It was really a job of plugging their numbers in
to various packages that they buy. And I have to
(32:26):
imagine that the companies that sell these modeling services or
software services or data services to any of the banks
that aren't like JP Morgan and a few others must
be making a mint.
Speaker 4 (32:36):
Oh absolutely, Look, I mean that's not my area. No,
But just in the same way, the MSCI has made
an absolute fortune by being the day you know, the
premier data company for markets.
Speaker 2 (32:47):
See.
Speaker 4 (32:47):
One way to frame it is in this of fifteen
years post financial crisis, the banks you know, in many
at least certainly for the first seven or eight, which
is focused on capital repair, improving process, improving risk management,
that the amount of discretionary that they had to invest
in new textacs was really quite low, and so a
lot of the innovation was happening outside banks and being
sold back in. Now, as you say, look from maybe
(33:09):
twenty sixteen onwards, the US banks got back on the
front foot, and the leading ones are investing disproportionately in
tech and their own solutions but there's an enormous amount
which is brought in and again that's sort of that's
why if you go back to private credit, one of
the areas they hope is is that they certainly the
leading firms are also investing in tech stacks because they
want to make sure they have an information edge. And
(33:30):
so also you're starting to see, i want to say,
hollowing out of the middle in private credit. But definitely
the larger firms are investing very significantly in treasury management
data and underlike.
Speaker 3 (33:41):
By the way, Tracy, check out look over a chart
of five five serves duck, which does a bunch of
various payment things for smaller and credit union banks and
stuff like that, and check out the Oh geez, yeah,
check out their stuck I just pulled it up.
Speaker 1 (33:55):
I have to compare it to in video.
Speaker 3 (33:57):
Yeah right, I know it looks like it hasn't it.
It's probably well anyway.
Speaker 1 (34:02):
Yeah, that's amazing. Why don't we get back to private credit.
We're in danger of just making this an AI episode.
(34:24):
But Hugh, you know, we've seen growth in private credit,
although to your point, it's still relatively small, so you know,
it's coming up from a low base. We've seen more
partnerships between banks and private credit entities. What's next in
terms of this dynamic? What are you watching out for
as the next big thing?
Speaker 4 (34:43):
So for me, private credit's next act is around asset
back lending and secondly commercial real estate, and I think
they're the two big asset classes which the private credit
firms are really trying to either gain origination or do
partnerships or get into and just go back to it. So,
if specialty finances are five and a half trillion market,
(35:05):
private credit has about a five point share. If you
then include consumer mortgages and commercial real estate, it gets
to about twenty five trillion in the States, of which
private credit has probably about a two percent share. So
this is an area where they are really trying to say,
with insurance led assets, with also some of the assets
for the wealthy. This is where they're really gunning for
it now. At the moment, commercial real estate is probably
(35:26):
less picked over because the areas where the banks are
shedding is more the distressed or stressed, particularly if it's
a US regional bank. But the asset back lending piece
is they're going absolutely gung ho, and that's the area
which I think is probably one of the most interesting
areas to spend time on. And then the second bit
trace is that's obviously on origination on the where they're
getting the assets from. As we've spoken about many times before,
(35:50):
Let's be honest, the endowments and pension funds are still
a lot of bit of have got a bit of
indigestion to private equity and venture capital. Now that indigestion's passing,
but most endowments I speak to still say they're abroout
five points over allocated to VC. Would love to put
that to private credit, but they just don't want to
do more I liquid assets today. So the private credit
(36:10):
firms are doing three things. Going international, so going to
the Middle East in particular, where there is just a
ton of new money, and actually that those clients really
like fixed income. They're going to insurers, and I still
think there's a good runway to raise money from insurers
we could discuss. And third and finally, it's the wealthy.
And I think at the moment there's a little bit
of misnomer. When they say wealthy, they mean seriously wealthy.
(36:33):
I mean they talk about you know, family offices, people
with fifty million dollars plus there's about a nine trillion
dollar market of family offices globally. That's their sweet spot,
but they're going to look increasingly towards the decently wealthy,
and I think their product innovation around, you know, whether
it's Capital International with KKR, where it's Black Crop with
Partners Group, whether it's Apollo with State Street Global, there's
(36:56):
some really interesting innovation about how you slice up private
credit to some of like affluent clients, and that's something again,
you could do a whole episode.
Speaker 3 (37:04):
On Tracy we've never done. I don't think a family
office episode. No, we should.
Speaker 1 (37:09):
Yeah, we should go to Singapore, Yeah and do it
from there. Yes, because I want to go back to Asia. Okay, Well, Hugh,
thank you so much for coming back on this show.
It was lovely to catch up with you as always,
and you walked us through that perfectly. So thank you
so much.
Speaker 2 (37:23):
Thanks for having me.
Speaker 3 (37:24):
Thanks you. That was fantastic.
Speaker 1 (37:38):
Joe, that was great. I love catching up with you again.
Like I've known him for a long time and he's
always had really interesting thoughts on the financial sector and
a great way of kind of explaining them. I do
think his idea of retranching of risk in the financial
system is definitely like the way to think about what's happening.
It seems like, in some respects seeing more and more
(38:00):
specialization in the system where maybe it used to be,
you know, back in nineteen seventy when bank lending was
at its height, the bank would do all sorts of
things right, But now it kind of breaks up all
those different businesses into different pieces and has different partners
for each one of those.
Speaker 3 (38:16):
No, I think that makes a lot of sense. Look,
I would still say, and you know famous last words
that someone will make fun of me, but I would
still say that by and large, I am of the
view that the post grade financial crisis evolution of the
financial system has probably been a net good in terms
of overall financial stability risk. That to your point about
(38:39):
the tranching, that the financial system has gotten better about
putting the right form of risk in the right hands.
There's never total delinkage or anything. But even hearing them
explain why financial lending to financial institutions is a safer
form of lending that is really helpful, and so why
that's grown like why you know, this emergence of his
(39:00):
specific mid market type lending and the right entities for that.
Speaker 2 (39:03):
I don't know.
Speaker 3 (39:04):
I'm still of the view that probably things are better.
Speaker 1 (39:07):
It's one of those things where there could always be
something that we're missing, yeah, of course, right, and that
regulators are missing. I do think at the moment we
seem to be in a sweet spot where a lot
of this is happening. So risk is getting divided up
and you know, distributed differently in the financial system to
where it was in two thousand and eight. But it's
still relatively small, like he was saying, despite all those
(39:28):
headlines about private credit, like, we're still talking about a
relatively small market. It could be that as it gets
bigger and bigger, it becomes more problematic in various ways.
But the other thing that I think is interesting about
private credit, and I think we've talked about it a
couple of times at this point, is the idea that
it kind of has acted as an additional cushion of
(39:48):
financing during the past couple of years where we had
really high rates and banks were still relatively capital constrained,
so you could still get a lot of you know,
middle market businesses have this addition layer of financing or
funding that they could still tap even if the banks
weren't necessarily doing it.
Speaker 3 (40:06):
The winner take all in this of banks.
Speaker 2 (40:08):
Oh yeah, really interesting.
Speaker 3 (40:09):
I think it's one of those things that you can
see and you can look at the comparison of large
caps for small caps or whatever, or JP Morgan versus
literally everyone else in you guys. But it is like
still sort of a little bit under discussed and underdiscussed
why And I get the point about the tech stack,
and I get the point about you know, capital markets.
There's a natural network effects, but it's still interesting. We
(40:29):
live in this network effects world and in almost any
industry this seems to be a phenomenon. And why that
is across so many different areas where you have a
number of companies in any industry that look like tech
stocks is an interesting under discussed phenomenon.
Speaker 1 (40:44):
Joe's theory of network effect.
Speaker 3 (40:46):
You know what I said, all companies are banks except banks.
Banks are media company.
Speaker 1 (40:53):
That's perfect. Yeah, I love that. Okay, let's leave it
there on a high note. Yeah, all right, this has
been another episode the Authoughts podcast. I'm Tracy Alloway. You
can follow me at Tracy Alloway, and.
Speaker 3 (41:04):
I'm Joe Wisenthal. You can follow me at the Stalwart,
follow our guest Hugh von steinas He's at Hugh Steinas,
Follow our producers Carmen Rodriguez at Carman Ermann Dashel Bennett
at dashbod In Kelbrooks at Keilbrooks. And thank you to
our producer Moses Ondam and from our Oddlots content. Go
to Bloomberg dot com slash odd lots, where you have transcripts,
a blog and a daily newsletter and you can chat
(41:26):
about all of these topics twenty four to seven in
our discord Discord dot gg slash od loots.
Speaker 1 (41:32):
And if you enjoy adlots, if you like it when
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(41:54):
the Bloomberg channel on Apple Podcasts and follow the instructions there.
Thanks for listening, Bend
Bloomberg Audio Studios, Podcasts, radio News. Hello and welcome to
another episode of the All Thoughts Podcast.
Speaker 2 (00:23):
I'm Tracy Alloway and I'm Joe Wisenthal.
Speaker 1 (00:26):
Joe, I feel like I start every private credit episode
with the same point, but I mean, private credit it's
everywhere right now. I think I counted like dozens and
dozens of stories on private credit that came out just
on the Bloomberg in the past week.
Speaker 3 (00:41):
There's two funny things that are going on. Which is
one private credit. So these non bank entities providing loans,
et cetera wanting to get into credit, and there's more
and more about that every day. And then there's banks
wanting to get more and more into private credit, which
is his own thing of Okay, you're still at the bank,
but you're doing it in some sort of bald and
she'd structure that resembles private credit, and what's up with that?
Speaker 1 (01:05):
What's up with that? Indeed, this is the what's up
with that? Episode? I'm so glad you asked that question.
But we're going to be talking about the relationship between
banks and private credit because the other thing that's been
happening is every time we talk to a bank or
a private credit entity on this show and we ask
about the relationship between regulated banks and non banks, you
(01:25):
get this really diplomatic, kind of awkward answer, like while
we view our bank partners as opportunities and no one
will really explain how they actually feel about each other totally.
Speaker 2 (01:37):
You know.
Speaker 3 (01:37):
The one other thing before we get into it that
I think about it a lot is I look at
the rise of private credit and there is a big
part of me that says, this is what regulatory success
looks like. This is what post DoD Frank's success looks like.
That there is more of this risk taking, right, this
was the intent, Yeah, happening outside of the deposit taking
banking institution. On the other hand, if a lot of
(02:01):
the leverage for private credit and a lot of these
relationships is being plied by banks and so forth, then
it makes me wonder, did we actually extricate the risk.
Speaker 1 (02:12):
Or in the air we just put a wrapper on it, we.
Speaker 3 (02:14):
Put a rapper on it. In the end, does all
financial risk readown back to the banking system?
Speaker 1 (02:19):
That's exactly it. And I got to say, you know,
there is a lot of discourse from which we can
pull from a lot of historical analogies, because of course,
bank disintermediation is not a new thing. It's basically been
happening for as long as we've had banks. And if
I think back to like two big moments in the
process of bank disintermediation, it has to be the invention
(02:39):
of the junk bond market in the nineteen eighties, securitization.
Also in the nineteen eighties and nineteen nineties, peer to
peer lending. That was a fun one, remember that.
Speaker 3 (02:49):
Well the other thing too, you know, it just occurred
to me. And bear Stearns was not a retail deposit
taking institution. But part of why they blew up is
like they had these in house hedge funds, right, and
so even this idea of hedge funds and non bank
entities sort of existing within more larger, traditional regulated financial
institutions is not that new. That was a story of
(03:09):
the Great Financial Crisis.
Speaker 1 (03:11):
That's exactly right. So I'm very happy to say this
is our banks and private credit basically Frenemies episode. We're
going to be speaking with really the perfect guest. It's
someone that I've known for a long time and we've
actually had him on the podcast before. But I don't
think you were there. I promise you are really going
to love this. We're going to be speaking with Hugh
van Steinis. He is the vice chair at Oliver Wyman
(03:33):
and also the former global head of Banking Research over
at Morgan Stantley. That's where I got to know his
during the depths of the euro Zone financial crisis when
I was on FT Alpha bel He's also formerly an
advisor to Mark Karney at the BOE. I think he
won like a series of research awards at various points
in his career, but really one of the smartest guys
(03:54):
I know when it comes to banks and financial So, Hugh,
thank you so much for coming on.
Speaker 2 (03:58):
All thoughts. Tracy, thanks so much for having me on.
Speaker 1 (04:02):
We are very excited. First of all, maybe let's just
start with the basic question, because everyone seems to have
different opinions, different numbers around this, But how big is
private credit at the moment compared to the traditional banking system.
Speaker 4 (04:17):
Oh, I mean, honestly, it's pretty tiny. So the official
stats are about one point seven trillion, and that's by Prequeen,
the company that Black Croc bought recently. That number, though
doesn't include insurers giving direct mandates to the private credit firms.
So I think it's probably closer to two and a
half to three trillion, which is a drop in the
ocean to what investment grade bond markets nine trillion banking
(04:38):
assets in Europe at thirty two trillion. These are really
relatively small numbers, and so I think that's why many
of these firms think they've got a long run way
still to grow.
Speaker 3 (04:46):
So why do we care. If not because they're so big,
it's just because it's growing.
Speaker 4 (04:49):
Fairst Well, it's also because they're eating away at bank earnings,
and I think that's where, you know, if I think
about our conversations with bank CEOs and CFOs, and I
literally just had one before coming on your show, they're
worried about how much of their juice is being gobbled up.
And I think that that's you know, that's why in way,
Tracy's Right has gone from sort of counterparts to frenemies.
(05:12):
And one way to think about it is that we
had a very unusual macro period. As you've spoken about
many times, during twenty twenty three, private credit players wrote
about ninety percent of all leverage loans, and they're also
doing really well in direct lending. And so they're looking
for the next avenue of growth. And one theme that
we come up across a lot is about asset back lending,
(05:33):
so in other words, financing i'd know, aviation, or auto
loans or even royalties. That's a five and a half
trillion dollar market in the States. Private credit probably has
less than five percent share, and they're really looking to
mine this seam. And so if you're a banker, thinking,
these guys are now after durre investment grade assets, not
just are the high old assets.
Speaker 1 (05:53):
So talk to us about how we got to this
point because Joe correctly, I think, attributed this to a
lot of the post two thousand and eight redesign of
the financial system regulation. And I mean, this is what
we wanted, right, We wanted the riskiest stuff, the riskiest
activity to be pushed away from regulated banks and into
(06:14):
I know they have the nefarious name of shadow banks,
but you know, mostly we're talking about like a business
development company or a direct lender or someone like that.
Speaker 4 (06:23):
No, look, I think that's right. So looks if you
take it since the financial crisis, where we changed the
rigs for the banking system, a lot more capital, a
lot less shortened the asset liability duration, a mismatch that
went beyond an elastic limit into the financial crisis. So
these private credit firms have created just over a trillion
dollar parallel system to lend to corporate America and parts
(06:47):
of corporate Europe. And it's around leverage lending its areas
which were either too risky or in some cases where
the FED put in limits on how many leverage loans
or what was the maximum you know, multiple of level
that a bank loan could take on. And so these
loans are being pushed outside of the banks. The other area, though,
where private credit has been very active to is mid market.
(07:09):
So let's say a loan between let's say thirty million
dollars to seventy five million dollars. That's a narrow where
for the top six banks, this is just too small
fry for them to get excited. And therefore so there
was us kind of a missing piece, which you know,
the private credit firms picked up the crumbs which are
left on the table by the bank. So you're right,
I think the regulators push this. I think where we're
going now is probably to the next level. And so
(07:32):
what I the way I think about it is that
we are now retranching the banking system where the banks
are laying off the junior risk to private credit, and
that's allowing them to optimize their capital, but quite frankly
also lend more. And so what's really interesting for me
is there's, like everything in life, people see things as
an opportunity or a threat. The top banks and CEOs
(07:52):
that I talk to are now saying, actually, private credit
allows me to recycle risk more quickly, I can lend more.
And then there's a whole bunch of banks who are
just sitting licking their wounds, going I'm not sure how
I can do this. So I think there is a
little bit symbiosis now between the banks and private credit.
Speaker 3 (08:06):
SORR explain that a little bit further, at least on
the opportunity side, when they can recycle their capital first,
just sort of walk us through.
Speaker 4 (08:13):
The Yeah, so Joe, let's take one of the top
top us banks or your banks. So there are three
ways they can lay off risk. The first would be
to say I will seed the loans that I don't
really want to write to give to a third party.
So in a way, what you've seen with Apollo and
City Group is the is the leverage lending or Brookfield
(08:36):
with Lloyd's in Europe. Again, it was around leverage lending.
So it's stuff that they didn't really want to do,
but they can arrange. They can get all sorts of
origination fees, and then they can also keep the relationship.
The second is if they let's say, originate a loan,
they then pass that up, maybe get one hundred loans
on hundred twenty loans, and then do a synthetic risk
transfer around this, in other words, start to basically which
(08:57):
I think you talked about two months ago on your show.
So in that case, think about a bell curve, you're
going to ensure the bottom ten percent, you're going to
take off the tail, and from a bank capital point
of view, that dramatically optimizes your capital at risk. So
the FED only permission this is about nine months ago.
You've already seen Morman, Sandy, Golden Sacks a number of
firms start to do these synthetic risk transfers. That space,
(09:20):
I think is going to grow really strongly because for
the largest firms it allows them to lend and then
do them. And then the third is then the more
you know, there's some more complexities as well around you know,
how else you can sort of lay off the risk.
Speaker 1 (09:47):
So one thing I'm always asking on the show is
how these conversations begin, because you know, I honestly have
no idea. Like, clearly there's a lot of partnering that's
happening between banks and private credit at the moment, but
when did that start? In your mind, what was the
first kind of big, notable instance of a bank teaming
(10:08):
up with some sort of private credit entity.
Speaker 2 (10:11):
Oh, that's a good question.
Speaker 4 (10:12):
So, as you were sort of hinted earlier on Tracy,
often in life a history of these things is far
longer than we like to believe. So just like actually
nineteen seventy three was the peak of bank lending as
a percentage of lending to corporates. I mean, it's what,
it's fifty years since that peak. So you're right, some
of these partnerships are actually about fifteen years old. One
or two of them predate the financial crisis. But if
(10:33):
you think about today, in the twelve months to September fourteen,
banks tied up deals with private credit, and in the
twelve months prior it was only two So it's basically
about a year ago. Suddenly it snapped. Now why is that.
I think it's because the private credit firms, particularly the
top ten, felt that started to max out of you know,
leverage lending or direct lending. But I think the subplot
(10:57):
is much more Shakespeare. I think there's a really interesting subplot,
which which is more of the top ten private credit
firms and now getting the assets from insurers. So take
yesterday we had the Blackstone results. Half their assets now
now come from insurance companies. Insurers can only invest investment grade.
So if you think about it from the point of
view the private credit player, they are structurally lowering their
(11:19):
cost of capital, which means that they can then go
after investment grade assets on the bank's balance sheets.
Speaker 2 (11:26):
And so that's subplot.
Speaker 4 (11:27):
I mean, I think now of the top ten firms
on my numbers, about forty percent of the assets come
from insurers. They become much more relevant to compete for
the investment grade pieces on the banks. And I think
that's what you know, whether it's the Barclays deal with Blackstone,
whether it's oak Tree with the SoC Gen, whether it's
City with Apollo. In a way, the private credit is
(11:48):
able to nibble away at more assets than they could
in the past.
Speaker 3 (11:52):
I'm going to back up and ask the dumb question.
I'm like, oh, I think maybe listeners are a lot
of clarification, but it's actually just me. What's the difference
between leverage lending and direct lending?
Speaker 1 (12:01):
Again?
Speaker 4 (12:02):
Oh, look, the this is one of these where the
MAENDC clature is pretty poor. Okay, I mean it's really poor,
and it's pretty blurry. I think the way they think
most of them would think about its direct lending is
I'm lending to a mid market company, you know, thirty
million dollars to one hundred million dollars, the kind of
a mid market finance, whereas lever lending is going to
be acquisition related finance.
Speaker 2 (12:22):
But okay, got it? Yeah, yeah, Joe, it's a it's
a it's a blurry fandomic.
Speaker 3 (12:26):
No, the acquisition related finance. That makes a lot of
sense to me.
Speaker 1 (12:31):
So I'm going to go back to that conversation point
and ask, Okay, so you know, a bank approaches a
private credit lender, or a private credit lender approaches a
bank and says, hey, we need to do something in
this environment. You know, there's a lot of demand. I've
got a bunch of insurance companies that are interested whatever,
how do they go about identifying what exactly they're going
to do and which particular assets are loans might be
(12:54):
realistic for this kind of partnership.
Speaker 4 (12:57):
Oh, it's a that's a great question, Tracy. So and
it cuts look some of these relations These firms are
being counterparts of the banks for many years, so there's
a degree of relationship, even if maybe historically being a
little bit antagonistic, and certainly one of the leaving product
credit firms you know, has a swear box for every
time they talk about a counterpart rather than a partner
these days, how.
Speaker 1 (13:15):
Much do you have to put in? Is it like
five thousand bucks or five dollars?
Speaker 4 (13:20):
Well, it probably should be five thousand, but I think
it's actually got it's the charity. It's a charity pot.
And so if we think about those deals, half have
been around asset back lending and half around the you know,
the overflow, the leverage finance or the more levered stuff.
So I think that what the private credit companies are
doing is very shrewdly going through that. They're almost doing
like my old job being a banks on list. They're
(13:41):
looking at a bank and saying where is capital constrained
at the end of the day, particularly in Europe, but
even in the state and even particularly think about US
regional banks or some of the European banks. They've become optimizers.
They're optimizing for a cost efficiency, capital efficiency and revenues.
And in that mindset of optimization, they're always looking to
try and lay off risk. And so the private credit
(14:03):
company often says, well, look, I see your capital constrained.
Speaker 2 (14:06):
You need to grow.
Speaker 4 (14:08):
An example would be let's say Blackstone with Barclays, they
want to grow their credit card business, but you know,
but equally want to keep lots of money in there
in their vestment bank. By partnering up, they can now
fuel the growth of the credit card business in a
way they couldn't do before, or did at least didn't
believe they could before. So I think this is, you know,
in a very constrained world. In fact, I was an
(14:30):
event last week with a bunch of investors and private
credit firms, and one of the investors said, well, look,
there is not enough capital for any bank to put
capital behind an acronym. You know that that's just space
is gone. You need to find partners and so I
think they're forensic. They're hiring people to do bank's analysts
for them, and then I look in to try and
(14:50):
create a solution because I said, the top ten firms
feel their origination constraint and so they need the access
to more assets.
Speaker 3 (14:58):
So in a situation like a credit card deal, what
the bank wants and the bank still has, and the
bank will probably still have, is that brand, that relationship,
that retail distribution network and so forth, and then the
private credit entity just allows them to keep growing these
lines and that they're presumably other lines without impairing their
(15:19):
balance sheet.
Speaker 2 (15:20):
Exactly.
Speaker 4 (15:21):
It's about optimizing the castle as well, because you know
it's at the end of the day, if you take
off the riskiest piece, will take off the entire slice.
Then you can just grow much faster.
Speaker 3 (15:29):
That's very helpful. Can you go further in talking about
the role of insurance and all this, because one of
the things that I still find actually completely strange is
that we have these gigantic financial entities called insurance companies
their bad meth and they're important all kinds of areas,
and no one ever talks about insurance companies Either's like
(15:50):
that you don't really see them in the media the
same way you see banks.
Speaker 1 (15:53):
It's very stress that and accounting. Yea, like the two
missing like major ingredients of financial.
Speaker 3 (16:00):
Financial of the financial ecosystem that seemed to like punch
and maybe they like it and punch it like you know,
ten percent of their weight in terms of our understanding
of their role. But talk a little bit more about
their role of insurance capital on a.
Speaker 4 (16:13):
This Oh, this is a great plot. And actually it's
very different in Europe versus the US. But let's say,
if you go back to Tracy point, the railways were
funded mostly by insurance companies. I mean large, large capital
projects were mostly funded by the insurers. So because they
had long dated funding and you still had wildcat you
know runs in the States as you as you may
not remember, but I was there. So so thet you know,
(16:34):
everyone's looked at Apollo and their arrangement with a theme
and seeing that they've created a very they've got a
very stable source of funding through their annuity business, much
like you know you might have seen through the last
actually before even before the financial crisis, hedge funds wanted
permanent capital vehicles, right, everyone wants ee wants to be
aligned to long data capital, and so I think, you know,
(16:56):
most of the top ten now have an insurance business.
So I mean I was just you know, I listened
to the Blackstone call yesterday, two one hundred and twenty
one billion other assets and now from insurers out of
four hundred and thirty two, so over half of their
credit assets come from insurers. Now, obviously that's great because
these are investors with long duration liabilities who need long
(17:16):
dated assets. So they're the right kind of people to
fund data centers, infrastructure assets, you know, the long dated
and stuff we need to fund our growth. But the
interesting thing for private credit is, rather than having to
go for i know, ten to thirteen percent return, if
they can just simply get one hundred to two hundred
basis points more than the insurer could have got through
(17:38):
the public markets, there actually quits in. And so certainly
the expectation for the CIOs of insurers I speak to
is if they can get one hundred and fifty one
hundred and seventy five basis points pick up on a
single a bond by buying a private bond rather the
public bond, if you compound that over ten years, that's
huge for the insurance sector. And so as I said,
I think about forty percent of the ass sets now
(18:00):
of the majors come from insurance. I think for the
industry as always between near thirty and so that's fueling
the growth and it's changing the nature of where private
credit can invest.
Speaker 3 (18:12):
By the way, Tracy, I didn't know that insurance companies
funded the railways, but I will say early on in
my career I do remember, and I sort of pat
myself on the back for this, I do remember having
the realization that sort of like clicked how similar banks
and insurance companies are. Because with the bank, you know,
you make a deposit of one thousand dollars and over
(18:33):
the lifetime the bank will probably give you back your
one thousand dollars in the form of you take it out.
Insurance companies basically the same. You buy a collect premium
and you get the you know on no but like
on average right for the industry, they pay out roughly
what they get in and they hope to like make
it on the float kind of. And so in the end,
like the models, in the ideal sense, it's just a
(18:55):
matter of timing of when the cash goat comes back.
Speaker 1 (18:58):
Out but in aggregate, right, aggregate, but not my individual experience.
Speaker 3 (19:01):
Some people get screwed and some people get way more
than they put in and then on average anyway, Yeah,
sort it sort of clicked to me one time in
my own.
Speaker 1 (19:10):
There's there's a lot of overlap here, for sure. Okay,
So I want to go back to the financial risk
slash regulation points. So we've established a number of times
that to some extent, this is exactly what regulators wanted
to see happen. But I think there's always a concern
that maybe this will come back to bite them and
the overall financial system in some unexpected way, and that
(19:31):
maybe there are avenues that some of this risk is
still entangled with the banking system, especially as we see
these new partnerships develop. What are the avenues for private
credit risk to I guess, re enter the banking system
and potentially cause problems.
Speaker 4 (19:48):
Look, I think it's a great question. I think I've
had almost every regulator post this question. This is this
is one of the very hot buttons for the issue
for them. So look, my take is that for sector
which is very low on leverage, doesn't have the big
asset liability mismatches is not systemically interconnected, and to be honest,
is still relatively small, less than three trillion. It's on
the whole, not a source of systemic risk. But the
(20:11):
question you gather therefore, well, are there pockets of leverage
that we can't see? So, for instance, the Bank of
England's got an investigation to think about where is the
hidden leverage because obviously having had the LDI problems under trust,
they're worried about hidden leverage. So nav finance is an
area which the regulators are pouring over and are getting
trying to get the data from firms just to see
(20:32):
as their leverage on leverage and the system that may
be you know, may trip them up. I think second
would be on the whole. If you've got ten plus two,
if the funds are ten year in duration, or even
even if they're six years and you're lending to five
year loans, there isn't a big asset liberty in mismatch.
But to the extent that private credit may potentially be
(20:54):
put into retail vehicles or even or even to ETFs,
is there going to be an asset liability mismatch. And
certainly the more that private credit looks to raise money
from retail, the more there's going to be a questions
around the structure. And we can come out to that
because there's a Cambrian explosion of interest of traditional asset
managers and private credit players teaming up to create commingle vehicles.
(21:15):
And then the third though, but tracy to your point,
is how do the tentacles overlap. So there is a
good piece by liberty streets. So like the Fed in
New York that twenty seven percent of bank loans are
now too non bank financial institutions, so hedge funds, private credit,
you know, a private equity and the like, and it's
been growing like a weed. And so they're war and
doing you know, you know, at one level they're very
(21:36):
happy that firms are laying off.
Speaker 2 (21:39):
Risk to private credit.
Speaker 4 (21:41):
But they but the question in fact, one of the
big central banks is asking the banks to try and
tos up every loan to private credit firm, every loan
to private credit firm, be in reality they're not making
the loan to the firm. They're doing it to the
underlying asset. But they won't have a consolidated tape because
you know what you don't know, you scares you, And
so they're trying to get a much better transparency on
(22:01):
this space.
Speaker 1 (22:02):
This kind of reminds me of the conversation we had
with Mickey Shemy about synthetic risk transfers, where you know,
it's sort of the same idea. The bank is like
selling off part of the risk of a lone portfolio
totally to another entity. And that sounds fine, except sometimes
those other entities who tend to be hedge funds or
someone like that, are borrowing from banks in order to
apply leverage to boost the yield.
Speaker 3 (22:24):
You say more about the twenty seven percent, I have
to go read the Liberty Street Economics report. But what
is from the bank's perspective that specific type of lending?
What are the risk characteristics?
Speaker 2 (22:36):
What are the.
Speaker 3 (22:37):
Capital impairment the capital cost characteristics of this kind of activity?
Speaker 4 (22:42):
Well, look, so by the way, I'll send you THEA.
I think it's about where do banks end and let
and private markets begin? All banks begin is the title,
So I think, look, it's very heterogeneous at the moment.
So it's hedge funds, and I know that my good
friend Tosin Slocke said that's to a new high it's
to private equity firms.
Speaker 2 (22:59):
So it's all over the place. But so I'm just
like what, Sorry.
Speaker 3 (23:02):
Jake, my question wasn't particularly sorry. I know, my particular
question wasn't particularly cogent.
Speaker 2 (23:08):
Here, it was worse.
Speaker 3 (23:10):
It's like, no, no, no, it's fine, it's fine. I'm just
trying to understand, Like, right, Okay, So banks are optimization vehicles,
they're capital optimization vehicles and so forth, and they want
to like, they want to do the lending that creates
the fewest constraints on the size for regulators and all
that stuff. So where does lending to financial institutions fit
into this sort of like madetrix of costs and benefits?
Speaker 4 (23:32):
Okay, So the way bank REGs work these days is
to encourage the banks to do senior or high quality
lending and to try and limit the amount of riskier lending,
either to try and originate and distribute it very quickly
or to lay it off through you know, derivatives of
some sort. Yeah, and so let's say it's it's lending
to hedge funds. Now, you know, because you've you've spoken
(23:53):
out before with archaegos, they got that wrong. But the
idea was up until then hedge fund lending. I mean
very low risk.
Speaker 3 (23:58):
For el So this is kind of what hedge fund
lending is considered to be low risk.
Speaker 1 (24:03):
Absolutely, although but I think that is changing, like there's
more scrutiny of the prime brokerage business.
Speaker 4 (24:08):
Yeah, exactly, Well, because they had a fifteen e run
with almost no credit losses, and obviously they had good
collateral with haircuts and if and this was the big
question with the firms who got the wrong way around
to our chaegoss was if they got the right haircuts,
then there was secured lending. So on the whole, they
you know, they could seize the assets and sell them off.
What they got wrong was this was such a concentrated
(24:30):
pool and they were all stampeding. So so I think
actually the risk here is not so much the belly,
it's actually the tail.
Speaker 2 (24:37):
So is there a scenario where there's.
Speaker 4 (24:39):
A major credit event and that many companies go bust
and then that works its way through and that's where
the regulators are trying to piece it through. But my
take is on the whole, the banks are trying to
retranch keep the senior risk and I cheekily put in
and the zen pick of the system because this was
a wave for them to lay off risk local.
Speaker 3 (24:59):
Directory very hard. Well, because in my mind, just sort
of very naively, I don't necessarily think of lending to
hedge funds is really safe lending, because aren't they taking
all kinds of crazy risks and doing all kinds of
stuff that may go wrong. But to your point, obviously
beyond just the run, the fact that there it's backed
by actual assets typically or typically the bank knows what
(25:21):
the assets are, I can understand more conceptually why lending
to financial institutions is more frequently perceived as safe. So
thank you for that, Joe.
Speaker 1 (25:29):
I think we should do a prime brokerage episode of
All Lots where all we do is a dramatic reading
of the report on credit Swiss and our ke ghost.
Speaker 2 (25:37):
Yeah, let's do it.
Speaker 1 (25:38):
We just do that, because that was amazing and actually,
well actually a really good insight into how it all works,
or you know, a bad example of how it should
not work. Anyway, Hugh, I'm going to ask a really
basic question, but I find, you know, the changing answers
to this one always really interesting. But how are banks
(25:59):
making money?
Speaker 4 (25:59):
Now? Oh? It's that Look, that's that's a really good question.
So after fifteen years of zero or negative rates, We've
had a wonderful couple of years where spread income, so
the spread between the assets liability once again became profitable,
and that really hurt the banks. But you know, if
the majority of my conversations, both Stateside and Europe and
(26:21):
even in Asia, as the banks want to make more
fee income, so that could be asset management, could be
private banking, could be originate to distribute. They want to
continue to shift more and more of their earnings towards
fees and less from just common and garden banking. And
that's partly cyclical. As interest rates are being cut now,
the anticipation is the kind of the spread is going
(26:41):
to be under a little bit of pressure, but you know,
as we've seen actually it's continued to be very good.
But it's more and more fees that's where that's really
where the banks are focused, and then within the loan income.
My sort of take is that the kind of winner takes.
Most dynamics we've seen in tech are starting to come
to banking. The more of a bank cost base, which
is the systems, the cloud data, you know, it's more
(27:05):
and more the cost space is tech well quite frankly,
it's very scalable, and so what you're starting to see
if you look at the roe. I actually did a
piece the other day where I looked at the ros
for the banks in every country by the number one player,
number two, number three, umber five. The top three players
in each market are doing so much better than the
tails than they wear a decade ago. And I think
it's that winner takes most win, it takes more behavior.
Speaker 3 (27:26):
That's really interesting. Actually, let's talk a little bit more
about this, because I have also from time to time
pull up the chart of JP Morgan and compare it
to other banks, and it is it looks kind of
like a tech dog. I mean, it's not really quiet
as good because it's not a techt Doug, but it
sort of seems to exhibit And I wondered about this,
this sort of winner take on this of the market
(27:48):
and whether there is a similar dynamic. And I hadn't
thought about it quite so literally in terms of the
actual tech stack of the bank, and I was wondering
if it was more sort of like a network effects.
And of course in finance work effects are important just
like they are in software. But talk to us a
little bit about the dynamics that you think are contributing
to this. Winner take on this in any country banking system.
Speaker 4 (28:11):
So look, I think obviously there's part of it is
the is the tech stack. Of course, you know, if
they're trading assets, there's always going to be some network effects.
If you can take you know, thirteen fourteen, fifteen percent
for market, you just see more, you can price better,
you've got better source of flow. So I think in
investment banking markets and in sort of wealth markets, there's
definitely some network effects, but also just there's scale in origination.
(28:34):
I mean, you just need loan officers, loan processors. I
mean it's very typically, it's very manual, and in fact,
one of the not for me, but some of our
colleagues are doing a lot of work actually using AI
to automate loan procedures for banks because that's an area
which is very physical, historically been very labor intensive. And
actually one of the reasons why private credit is trying
(28:54):
to team up with the banks is because they don't
have enough people to originate, so they're trying to lean
on someone else's origination STAF. Now, look, but just there's
one nuance here for every power, there's an equal and
opposite power. So in the States, let's say for regional
back for the smallest banks, they're all basically sitting on
one of three players like five serv So they're enjoying scale,
but they're just outsourcing it. And then the other thing is,
(29:17):
of course, you know the Google's alphabets and as you're
within Microsoft are getting a winning handover fist because if
you're a MidCap bank, the way you try to capture
scale is by outsourcing to one of the superscalers.
Speaker 1 (29:29):
I think you anticipated my next question perhaps when you
brought up AI. But one thing I often think about
the financial sector, so banks and insurance companies, is if
AI is Obviously it's about the technology, but it's about
the data too. Who has the most data? It's got
to be insurers and banks, right, they just have noodles
and oodles of it. How excited are banks in particular
(29:52):
getting about, you know, the actual data component of their
business here?
Speaker 2 (29:58):
Well, hopefully Bloomberg's got one of the best data staffs.
Well us too.
Speaker 4 (30:03):
Oh no, this is so there's a huge amount of
automation going on. I mean, look, let's take one step back.
The banks need to make sure that their data is
organized in a lake or in a way it can
be used effectively. And then number two, you need to train.
So actually one of the largest banks now has every
new graduate doing AI prompt training as part of their
core curriculum as they join. So one of my son's
(30:23):
flatmates just done eight weeks of AI training. It's extraordinary.
So the way, of course, if the more data you've got,
the better. But Tracy, there's some really subtle things in here,
because the regulators want to know how you made the
decisions right, and is the a optimizing just on past
experience or is it right?
Speaker 1 (30:40):
This is the black box alg point, right, where like
if you have all this data going into a black
box and algorithm and it's spitting out an answer, you
actually have to know whether that answer is valid, like
whether it might violate regulations on biased lending based on
like racial or age characteristics or gender or something like that.
Speaker 4 (31:00):
Absolutely, and so there's all sorts of bites. So at
the moment, most of it is for co piloting, but
you know, some of the use cases, Tracy, are fascinating.
It's like one of the big banks I was talking with,
they're actually using AI now in the right sharp departments
to just basically automate and a thing. If they want
to fask someone, they just they click a big thing
less and then try and work it out.
Speaker 1 (31:18):
Oh wow, dystopia is here.
Speaker 3 (31:20):
Yeah, it really is. There's some great articles, by the way,
done by Bloomberg, not related to banks or anything, but
like on the sort of like Amazon auto hiring and firing,
and just this idea of all that being the assumption
of liquid labor markets and the you know, it's okay
to make mistakes if there's just an endless supply of
people who want to work at your company. Anyway, that's
its own digression, you know, just on this point. So obviously, okay,
(31:43):
the big banks have their gigantic text ex. I had
a conversation recently with someone who worked for a very
small bank. Actually it was just like someone over coffee
and I'm curious and so it's like kind of like
doing an odd lots except over coffee with no microphone,
like how it all works and how a region or
a small local bank actually has a business. And it
(32:04):
was really striking in the conversation how many of the
specific things that came up were literally about third party
modeling or software packages and stuff like that, and how
much the sort of all kinds of risk management, et cetera.
It was really a job of plugging their numbers in
to various packages that they buy. And I have to
(32:26):
imagine that the companies that sell these modeling services or
software services or data services to any of the banks
that aren't like JP Morgan and a few others must
be making a mint.
Speaker 4 (32:36):
Oh absolutely, Look, I mean that's not my area. No,
But just in the same way, the MSCI has made
an absolute fortune by being the day you know, the
premier data company for markets.
Speaker 2 (32:47):
See.
Speaker 4 (32:47):
One way to frame it is in this of fifteen
years post financial crisis, the banks you know, in many
at least certainly for the first seven or eight, which
is focused on capital repair, improving process, improving risk management,
that the amount of discretionary that they had to invest
in new textacs was really quite low, and so a
lot of the innovation was happening outside banks and being
sold back in. Now, as you say, look from maybe
(33:09):
twenty sixteen onwards, the US banks got back on the
front foot, and the leading ones are investing disproportionately in
tech and their own solutions but there's an enormous amount
which is brought in and again that's sort of that's
why if you go back to private credit, one of
the areas they hope is is that they certainly the
leading firms are also investing in tech stacks because they
want to make sure they have an information edge. And
(33:30):
so also you're starting to see, i want to say,
hollowing out of the middle in private credit. But definitely
the larger firms are investing very significantly in treasury management
data and underlike.
Speaker 3 (33:41):
By the way, Tracy, check out look over a chart
of five five serves duck, which does a bunch of
various payment things for smaller and credit union banks and
stuff like that, and check out the Oh geez, yeah,
check out their stuck I just pulled it up.
Speaker 1 (33:55):
I have to compare it to in video.
Speaker 3 (33:57):
Yeah right, I know it looks like it hasn't it.
It's probably well anyway.
Speaker 1 (34:02):
Yeah, that's amazing. Why don't we get back to private credit.
We're in danger of just making this an AI episode.
(34:24):
But Hugh, you know, we've seen growth in private credit,
although to your point, it's still relatively small, so you know,
it's coming up from a low base. We've seen more
partnerships between banks and private credit entities. What's next in
terms of this dynamic? What are you watching out for
as the next big thing?
Speaker 4 (34:43):
So for me, private credit's next act is around asset
back lending and secondly commercial real estate, and I think
they're the two big asset classes which the private credit
firms are really trying to either gain origination or do
partnerships or get into and just go back to it. So,
if specialty finances are five and a half trillion market,
(35:05):
private credit has about a five point share. If you
then include consumer mortgages and commercial real estate, it gets
to about twenty five trillion in the States, of which
private credit has probably about a two percent share. So
this is an area where they are really trying to say,
with insurance led assets, with also some of the assets
for the wealthy. This is where they're really gunning for
it now. At the moment, commercial real estate is probably
(35:26):
less picked over because the areas where the banks are
shedding is more the distressed or stressed, particularly if it's
a US regional bank. But the asset back lending piece
is they're going absolutely gung ho, and that's the area
which I think is probably one of the most interesting
areas to spend time on. And then the second bit
trace is that's obviously on origination on the where they're
getting the assets from. As we've spoken about many times before,
(35:50):
Let's be honest, the endowments and pension funds are still
a lot of bit of have got a bit of
indigestion to private equity and venture capital. Now that indigestion's passing,
but most endowments I speak to still say they're abroout
five points over allocated to VC. Would love to put
that to private credit, but they just don't want to
do more I liquid assets today. So the private credit
(36:10):
firms are doing three things. Going international, so going to
the Middle East in particular, where there is just a
ton of new money, and actually that those clients really
like fixed income. They're going to insurers, and I still
think there's a good runway to raise money from insurers
we could discuss. And third and finally, it's the wealthy.
And I think at the moment there's a little bit
of misnomer. When they say wealthy, they mean seriously wealthy.
(36:33):
I mean they talk about you know, family offices, people
with fifty million dollars plus there's about a nine trillion
dollar market of family offices globally. That's their sweet spot,
but they're going to look increasingly towards the decently wealthy,
and I think their product innovation around, you know, whether
it's Capital International with KKR, where it's Black Crop with
Partners Group, whether it's Apollo with State Street Global, there's
(36:56):
some really interesting innovation about how you slice up private
credit to some of like affluent clients, and that's something again,
you could do a whole episode.
Speaker 3 (37:04):
On Tracy we've never done. I don't think a family
office episode. No, we should.
Speaker 1 (37:09):
Yeah, we should go to Singapore, Yeah and do it
from there. Yes, because I want to go back to Asia. Okay, Well, Hugh,
thank you so much for coming back on this show.
It was lovely to catch up with you as always,
and you walked us through that perfectly. So thank you
so much.
Speaker 2 (37:23):
Thanks for having me.
Speaker 3 (37:24):
Thanks you. That was fantastic.
Speaker 1 (37:38):
Joe, that was great. I love catching up with you again.
Like I've known him for a long time and he's
always had really interesting thoughts on the financial sector and
a great way of kind of explaining them. I do
think his idea of retranching of risk in the financial
system is definitely like the way to think about what's happening.
It seems like, in some respects seeing more and more
(38:00):
specialization in the system where maybe it used to be,
you know, back in nineteen seventy when bank lending was
at its height, the bank would do all sorts of
things right, But now it kind of breaks up all
those different businesses into different pieces and has different partners
for each one of those.
Speaker 3 (38:16):
No, I think that makes a lot of sense. Look,
I would still say, and you know famous last words
that someone will make fun of me, but I would
still say that by and large, I am of the
view that the post grade financial crisis evolution of the
financial system has probably been a net good in terms
of overall financial stability risk. That to your point about
(38:39):
the tranching, that the financial system has gotten better about
putting the right form of risk in the right hands.
There's never total delinkage or anything. But even hearing them
explain why financial lending to financial institutions is a safer
form of lending that is really helpful, and so why
that's grown like why you know, this emergence of his
(39:00):
specific mid market type lending and the right entities for that.
Speaker 2 (39:03):
I don't know.
Speaker 3 (39:04):
I'm still of the view that probably things are better.
Speaker 1 (39:07):
It's one of those things where there could always be
something that we're missing, yeah, of course, right, and that
regulators are missing. I do think at the moment we
seem to be in a sweet spot where a lot
of this is happening. So risk is getting divided up
and you know, distributed differently in the financial system to
where it was in two thousand and eight. But it's
still relatively small, like he was saying, despite all those
(39:28):
headlines about private credit, like, we're still talking about a
relatively small market. It could be that as it gets
bigger and bigger, it becomes more problematic in various ways.
But the other thing that I think is interesting about
private credit, and I think we've talked about it a
couple of times at this point, is the idea that
it kind of has acted as an additional cushion of
(39:48):
financing during the past couple of years where we had
really high rates and banks were still relatively capital constrained,
so you could still get a lot of you know,
middle market businesses have this addition layer of financing or
funding that they could still tap even if the banks
weren't necessarily doing it.
Speaker 3 (40:06):
The winner take all in this of banks.
Speaker 2 (40:08):
Oh yeah, really interesting.
Speaker 3 (40:09):
I think it's one of those things that you can
see and you can look at the comparison of large
caps for small caps or whatever, or JP Morgan versus
literally everyone else in you guys. But it is like
still sort of a little bit under discussed and underdiscussed
why And I get the point about the tech stack,
and I get the point about you know, capital markets.
There's a natural network effects, but it's still interesting. We
(40:29):
live in this network effects world and in almost any
industry this seems to be a phenomenon. And why that
is across so many different areas where you have a
number of companies in any industry that look like tech
stocks is an interesting under discussed phenomenon.
Speaker 1 (40:44):
Joe's theory of network effect.
Speaker 3 (40:46):
You know what I said, all companies are banks except banks.
Banks are media company.
Speaker 1 (40:53):
That's perfect. Yeah, I love that. Okay, let's leave it
there on a high note. Yeah, all right, this has
been another episode the Authoughts podcast. I'm Tracy Alloway. You
can follow me at Tracy Alloway, and.
Speaker 3 (41:04):
I'm Joe Wisenthal. You can follow me at the Stalwart,
follow our guest Hugh von steinas He's at Hugh Steinas,
Follow our producers Carmen Rodriguez at Carman Ermann Dashel Bennett
at dashbod In Kelbrooks at Keilbrooks. And thank you to
our producer Moses Ondam and from our Oddlots content. Go
to Bloomberg dot com slash odd lots, where you have transcripts,
a blog and a daily newsletter and you can chat
(41:26):
about all of these topics twenty four to seven in
our discord Discord dot gg slash od loots.
Speaker 1 (41:32):
And if you enjoy adlots, if you like it when
we discuss financial frenemies, then please leave us a positive
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(41:54):
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Thanks for listening, Bend
Hosts And Creators
Joe Weisenthal
Tracy Alloway
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